On March 31, 2014 the Tax Court issued a Supplemental Memorandum Opinion in Kaufman v. Commissioner, T.C. Memo. 2014-52. The case appeared before the Tax Court on remand from the U.S. Court of Appeals for the First Circuit and the issues to be decided on remand were the value of the easement, if any, and whether accuracy-related penalties should be imposed.
The Kaufman saga began when the Tax Court held that the taxpayers’ grant of a façade easement over a historic row house was not protected in perpetuity and thus was not a qualified conservation contribution. The court’s holding was based on language contained in the subordination agreement between the mortgagee of the property and the preservation trust. Because the easement did not meet the technical requirements of the Internal Revenue Code, the Tax Court disallowed the entire deduction. The Tax Court next addressed whether the taxpayers were liable for valuation penalties. Noting that the deduction was totally denied on grounds other than valuation (i.e. the valuation issue was never reached), the Tax Court reasoned penalties were not applicable. The taxpayers appealed.
On appeal, the First Circuit rejected the Service’s and Tax Court’s position. The First Circuit’s opinion was important because it addressed and discarded many technical arguments which had been made by the IRS in other cases concerning the subordination issue. However, as was inevitable, the case was remanded back down to the Tax Court to determine the value of the conservation easement.
On remand, the Tax Court determined the value of the easement (i.e., preservation restriction agreement) to be zero. The Tax Court criticized the taxpayer’s appraiser and concluded that the appraisal method he used was not reliable. The Tax Court further stated that it was convinced that the restrictive provisions in the preservation agreement were basically duplicative of the local zoning ordinance and related restrictions, thus the easement did not materially diminish the value of the row house.
In regards to penalties, the Tax Court found that the issue was now on the table. The court determined petitioners’ reported value for the façade easement exceeded the correct value by 400% or more, constituting a gross valuation misstatement and, further, that the 40% gross valuation misstatement penalty should be imposed.
Although finding the facade easement was based on a qualified appraisal made by a qualified appraiser, the Tax Court ultimately found that Petitioners reliance on their accountant and appraiser did not satisfy their burden to show that they conducted a good faith investigation of value or acted with reasonable cause.
A Side Note
Underlying the court’s penalty determination (as well as the court’s value determination), was some unfortunate evidence that came to light during trial. Specifically, the donee of the easement had represented to Mr. Kaufman (the donor), a sophisticated MIT Emeritus Professor of Statistics, that the easement would not reduce the value of the underlying property. Despite these written communications, the Kaufmans proceeded, without further investigation, to claim charitable deductions based on the appraiser’s estimated $220,800 reduction in the value of the property.
Perhaps the most notable of many lessons from the case can be summed up as follows: If you don’t want it being brought up in court, you shouldn’t write it. And, if you shouldn’t write it, you should probably think twice before doing it…